Illinois’ Sales Taxes: A Deeper Dive on Exclusions and Exemptions

Keith Staats, JD Executive Director, Illinois Chamber Tax Institute
Deciphering Today's State & Federal Tax Law

Once again, I’m diving back into a familiar topic that affects all of us—Illinois’ sales taxes. This time, however, I’m taking a deeper dive into the exclusions and exemptions from the taxes.

But first, let’s do a quick refresher on Illinois’ different sales taxes. As I’ve highlighted in previous Insight columns (the fall 2022 issue, to be exact), you may remember that the Illinois sales tax consists of a combination of four taxes:

• The Retailers’ Occupation Tax: This is a tax on tangible personal property (TPP) sold at the retail level (generally by Illinois-based sellers to end users).
• The Use Tax: This tax is imposed on purchasers of TPP (e.g., purchases made from websites of out-of-state online sellers).
• The Service Occupation Tax: This tax isn’t what the name implies (i.e., a tax on services). Rather, it’s a tax on TPP that’s transferred in the course of a sale of service (e.g., the selling price of the parts when your car is repaired).
• The Service Use Tax: This is a tax on TPP that’s transferred in the course of a sale of service that occurs outside of the state (e.g., your business orders items that are custom printed from an out-of-state printer and are delivered to Illinois recipients).

Now, let’s get into how exclusions and exemptions apply to these taxes. Although exclusions and exemptions sound the same, they’re quite different (legally speaking). Here, I’ll explain.

EXCLUSIONS

Exclusions are transactions outside the scope of the sales tax (i.e., the types of transactions that are taxed vs. those that aren’t). Illinois’ sales taxes are imposed on sales of TPP, not intangibles—but, as you can imagine, there are recurring debates over what’s considered “tangible.”

Unlike many other states, Illinois’ sales taxes don’t generally impose taxes on services (hence, the definition above on the Service Occupation Tax). For example, when your car is repaired and the mechanic gives you a bill that breaks down the charges for services and parts, you’ll notice that the parts are taxed but the services aren’t. That’s because the only services that Illinois currently taxes (via other tax acts) are telecommunications, hotels, and car rentals, among others.

Other exclusions include leases. Illinois generally doesn’t tax rentals of TPP except for automobiles and certain rent-to-own transactions. On the other hand, the City of Chicago, through the Personal Property Lease Transaction Tax, taxes rentals of items that fall within the city’s definition of personal property. The details of this Chicago tax are a subject for a future column.

EXEMPTIONS

Over the years, Illinois’ sales taxes have been amended many times to exempt various types of sales and transactions. Exemptions are transactions that fall within the scope of the tax—for example, sales of TPP—but the law carves out these transactions from being taxed.

A classic exemption is the sale or purchase of an item for resale. Illinois law carves out sales of TPP under the Retailers’ Occupation Tax and purchases of TPP under the Use Tax. In order to qualify for the exemption, the items can either be resold in the same form or resold in a different form as an ingredient or component of a manufactured item. Additionally, the manufactured item could also likely be sold for resale to another manufacturer (think of an auto parts manufacturer that sells to an automobile manufacturer) or to a retailer who will make a taxable sale to an end user.

Other common Illinois exemptions include:

• Charitable, religious, educational, or government organizations. However, exemptions for charitable organizations vary in scope and requirements. For example, before being authorized to make sales tax exempt purchases, Illinois requires that a charitable organization apply to the state, submit required documentation, and receive a tax exemption identification number. Other states tie the exemption to federal status under Section 501(c)(3) of the Internal Revenue Code.
• Manufacturing machinery and equipment. Most states have some form of an exemption to manufacturing machinery. Notably, Illinois has a broad definition for this exemption.
• Interstate commerce. For example, a purchase from an Illinois retailer that’s shipped by the retailer to an out-of-state location. Of course, these types of transactions are likely to be subject to a use tax in the state where the item is being shipped—unless it’s one of the handful of states without sales and use taxes.
• Planes, trains, trucks, etc. used as rolling stock. The requirements for this exemption aren’t uniform between the various types of conveyances and vary from state to state.

While exemptions for medicines and food are common in many states, Illinois handles it a bit differently. Illinois taxes medicines and food at a lower tax rate and provides all the proceeds of the tax to local governments.

Overall, it’s critical to understand the particular exemption rules of the state in which your client is doing business. This is because exemptions must be documented to the satisfaction of the taxing authority. Of course, documentation requirements vary from state to state.

EXCLUSION VS. EXEMPTION

So, why does it matter if a particular transaction is excluded or exempted from tax? There are a couple of reasons. First, as previously noted, there are generally eligibility and documentation requirements under the law for claiming an exemption from tax. Second, in the event of a dispute with a taxing authority, the burden of proving a transaction is non-taxable differs as a legal matter between exclusions and exemptions. In the case of exclusions, generally the courts strictly construe the statutes in favor of non-taxability and the burden is on the taxing authority to make an initial showing that the transaction is subject to tax. In the case of an exemption, generally the courts strictly construe the statutes in favor of taxability and the burden is on the taxpayer to demonstrate that the transaction is exempt under the law and that they complied with all the legal requirements to claim the exemption.

As you can see, there are deep legal waters to dive through in Illinois’ sales taxes, especially for exclusions and exemptions. Knowing the nuances is critical for you and your clients.

Related Content:

• Decoding Illinois’ Major Sales Tax Exemptions: While all sales of tangible personal property are presumed taxable, Illinois law does offer various exemptions. Here’s a rundown of the state’s major sales tax exemptions.
• Illinois’ Corporate Income Tax: Never-Ending Complexity: Having the state’s income tax mirror the federal tax base seems simple enough, but decoupling from federal tax treatment makes it anything but.